2012 Quarterly Summaries

Review of Securities Markets, Fourth Quarter, 2012

Investors focused on political showdowns during the fourth quarter of 2012. After a rancorous campaign, voters went to the polls in November to elect President Obama to a second term. Despite hotly‐contested Congressional races across the country, the Republicans retained their majority in the House of Representatives and the Democrats continue to control the Senate. The ballots were barely counted before the “fiscal cliff” became the prevalent headline. For the remainder of 2012, investors mulled the likelihood of a compromise on tax increases and spending cuts slated for 2013. Deliberations went into the new year and a last‐minute bill partially addressing the cliff was signed into law on Wednesday, January 2. While many workers will experience higher taxes in 2013 due to the expiration of the payroll tax cut, many proposed tax increases were averted with the new legislation. Negotiations regarding spending cuts were left for another day.

U.S. stocks as measured by the S&P 500 were slightly negative in the fourth quarter as investors waited for news about the legislation and considered mixed signals about the nascent economic recovery. Other types of U.S. stock investments, including small company and value stocks, posted moderate gains. Technology stocks fared the worst as Apple’s earnings disappointed investors. Apple represents roughly 18% of the Nasdaq 100 and nearly 4% of the S&P 500 so its 20% price decline during the quarter had an outsized impact on index returns. Foreign stocks beat U.S. stocks. The European Central Bank (ECB) managed to keep the sovereign debt crisis under control, encouraging investors to question whether the worst may be over for the region. Japanese stocks rallied as a pro‐growth party won recent elections. Emerging market returns were similar to the developed market gains in the fourth quarter.

U.S. bond returns were modest. Foreign bonds declined as the dollar strengthened relative to the Japanese yen. The newly‐elected leadership is expected to engage in monetary easing in an attempt to create some inflation in Japan. The anticipation of this activity caused investors to flee the yen in search of higher‐yielding investments. As a result, the yen fell in value relative to other currencies. A cheaper yen makes Japanese goods more affordable overseas as the country seeks to export its way to sustainable economic growth.

Throughout the year, investors were willing to embrace risk despite lingering uncertainties. Foreign and U.S. stocks posted gains well in excess of historical averages. U.S. bond returns were positive despite the low interest rate environment. As in recent years, market commentators speculated on whether accomodative monetary policy around the world emboldened investors. It was clear that news from central bankers was anxiously anticipated throughout the year. In retrospect, central bank signaling and policy was probably one of the more important themes for investors during 2012.

“…And Believe Me, It Will Be Enough…”

On July 26, Mario Draghi, the President of the ECB, gave a speech with one of the most significant statements delivered by a central banker in recent memory. He said, “within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

Draghi’s speech came as the ECB was preparing the specifics of its Outright Monetary Transactions (OMT) program, a plan to purchase sovereign debt in the secondary market to restore investor confidence in Europe’s commitment to the monetary union. Draghi was not intending hyperbole when he made this statement. His comments implied, perhaps for the first time, that the ECB would print significant amounts of money to purchase the debt of weak eurozone members. In a sense, Draghi was issuing a warning to any investor who would bet on, and try to profit from, the default of euro‐denominated debt. Investors were encouraged and bought riskier assets including the debt of the weaker eurozone countries. Greek bonds rallied over 200% in the second half of the year as Draghi’s convincing statement and the development of the OMT reduced the possibility of a disorderly break‐up of the eurozone. It remains unlikely that these investors expect the emergence of a robust Greek economy that would transform the country into a self‐sustaining and financially independent nation. In other words, investors are betting on the ECB, not the Greek economy.

The ECB leadership wasn’t alone in its attempt to inspire confidence. In 2012, central bankers around the world continued programs to stimulate their economies after years of lackluster growth. Our own central bank, the Federal Reserve, drove rates to historically low levels in 2012 with its large, unconventional and ongoing purchases of fixed income securities. When interest rates are low, consumers can afford to buy homes and cars. Since consumer purchases represent roughly 70% of gross domestic product, the ability and willingness of consumers to spend money, even if it is borrowed, is key to growth in the economy.

Years from now, history will inform us on the effectiveness of current monetary policy decisions. We can’t know with certainty how central bankers around the world will wean investors – and entire economies – off easy‐money dependence. Meanwhile, there are many reasons to be cautiously optimistic about the U.S. economy. Housing starts, while still below historical averages, are picking up recently. Existing home inventory has returned to more normal levels. Consumers have pared back on personal debt. Unemployment has shown some slow yet steady improvement. Inflation remains contained even though there are periodic spikes in food and energy prices. Tax policy has been determined, at least temporarily. Corporations have hoards of cash that could be deployed to hire employees and make capital investments.

Although it has been, and will continue to be, an uneven economic recovery, the 2012 stock and bond markets seem to indicate that investors are sanguine about the future. Perhaps central banks around the world have finally convinced us that they can manage in this uncertain world. Whether the banks can live up to that responsibility is one of the biggest unknowns for investors. We are watching closely and carefully considering how varying developments will affect our clients’ portfolios.

Key Economic Indicators

Real Gross Domestic Product (real GDP) in the U.S. increased at an annual rate of 3.1% in the third quarter of 2012. This was up from an increase of 1.3% in the second quarter.

In its meeting in October, the Federal Reserve agreed to continue holding the target range for the federal funds rate at 0% to 0.25%. It also agreed to continue its purchase of agency mortgage‐backed securities at a pace of $40 billion per month.

The U.S. unemployment rate held steady at 7.8% in December. The number of long‐term unemployed accounts for 39.1% of the total unemployed.

Standard & Poor’s 500 Index third quarter operating earnings per share declined 5.6% quarter over quarter. Earnings declined 5.1% from the same quarter last year. Earnings for the fourth quarter 2012 are estimated to increase at 5.4%.

The Comex spot rate for gold rose 7% in 2012, closing at $1,675.60 per ounce.

U.S. crude oil closed the year at $91.79 a barrel. The overall price of oil was down 7% for the year. Investors have been leery of the underlying strength of the global energy market, where demand is weak and supplies are rising.

This information is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. It is the responsibility of any person or persons in possession of this material to inform themselves of and to take appropriate advice regarding any applicable legal requirements and any applicable taxation regulations which might be relevant to the subscription, purchase, holding, exchange, redemption or disposal of any investments.

This information does not constitute a solicitation in any jurisdiction in which such a solicitation is unlawful or to any person to whom it is unlawful. Moreover, this information neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to the document by making an offer to enter into an investment agreement.

The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur.

Opinions expressed are current opinions as of the date appearing in this material only. No part of this material may, without Bingham, Osborn & Scarborough, LLC’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

(1) Source: MSCI. Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties or originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.